This research contributes to the initial engagement literature by providing evidence thatsuccessor auditors charge higher fees to their clients that previously reported disagreements andother reportable events. The authors also contribute to the literature by examining fees over a six-year period surrounding the auditor change. More importantly, they find that only Big 4 auditorsappear to charge higher fees following disclosures of disagreements and other reportable events.Finally, the authors add to the existing literature on audit fees for risky clients, especially theinternal control weakness literature, by providing evidence that disagreements and otherreportable events are priced incremental to internal control issues.

In this study, the authors reexamine the association between audit fees and risky initialengagements by developing an ex ante client-risk metric that is based on auditor change 8-Kfilings. They group adverse disclosures embedded in auditor change filings into four categories:clients with

Internal control weaknesses,

Going concern issues or those filing for bankruptcy,

Disagreements with the predecessor auditor, and

Other reportable events.

Because prior studies examine internal control weaknesses and going concern opinions, theauthors focus on auditor-client disagreements and other reportable events, includingrestatements, management integrity issues, scope limitations, illegal acts, and reaudits. Afundamental distinction between this study and prior studies on risk and fees is that the authorsmeasure client risk based on public information available to auditors before they accept anengagement.

The authors investigate the association between an ex ante measure of risk (using information inauditor change 8-K filings) and audit fees for initial engagements. The authors also examinewhether the size of the successor/predecessor auditor affects fees. Finally, they examine inter-temporal fee changes, i.e., how fees change subsequent to a switch and how fees change prior tothe switch, for both risky and other clients.

Design/Method/ Approach:

The auditor change and fee data are obtained from Audit Analytics. Data for the financialvariables are from Compustat Annual files. The final sample consists of 2,396 auditor switchesover the years 2001 to 2011. The categorization based on auditor change 8-K filings indicatesthat 317 auditor switches have a disagreement or other reportable event disclosed in the filings,while the remaining 2,079 observations do not report any such issue.

Findings:

The authors find that firms disclosing reportable events or auditor-client disagreementspay a fee premium of about 23 percent compared to less risky initial engagements.

They find that only clients switching to Big 4 auditors pay higher fees when disclosingdisagreements or other reportable events in the 8-K.